I just celebrated my 50th birthday last week. When you are young and investing you think to yourself that you have time to ride out all the ups and downs of the market. I stayed in the market back in 1987 when the big October crash took away all of the gains I had made on my first mutual fund investment. I hung in there again when the market was down 35% after the dot.com crash and again when the market was down 40% in 2008.
But as I’ve been approaching, and now passed, age 50, I don’t put any more faith in long-term market trends. I’ve got a chart on my Company’s website that shows the S&P500 returns from 2000 to 2014. I show this because it illustrates that someone who is 50 cannot count on the market recovering in time to build up their retirement savings again.
Preservation of principal isn’t just important for those of us approaching retirement age. Life throws out a lot of curve balls and it is important to have access to your savings at any age. I recommend using an over funded, equity-indexed universal life insurance plan to create tax-free retirement income. In my first article weeks ago I mentioned that I had read Dave Ramsey’s “Total Money Makeover”. I wrote about how I agreed with his main premise of getting yourself out of debt. I also mentioned that I took exception to a couple of his other recommendations.
Dave, unlike me, is no fan of Permanent Life Insurance. He advocates buying cheap term life insurance and putting your savings into growth mutual funds which he states have earned 12% throughout its history. He even states that it is never too late to start a savings program. He mentions “Gayle” on page 148 who is in her 50s and is going to start taking advantage of the power of 12% compounding returns. Did Dave live through the dot.com and housing market collapses? If Gayle started this savings plan in 2000, she probably won’t be retiring next year like she had planned to.
Dave doesn’t spend a lot of time explaining his reasoning for purchasing term and investing the difference. I suppose he thinks that you can invest your own money better than the insurance company. Maybe he thinks that because Life Insurance includes the cost of Life Insurance, then its return on investment can’t be as good as a mutual fund.
I can think of at least four main reasons why buying term insurance and investing the difference is a myth.
First, the cash value of life insurance is accessed via a policy loan. That means there is no income tax to pay. So even if a simple strategy based on using an over-funded, Equity-Indexed universal life is slightly outperformed by the raw performance of the underlying index, when you factor in the favorable tax treatment, the life insurance strategy is superior. Taxes will likely whittle Dave Ramsey’s 12% gross return on his growth funds to only 8% net returns. Thanks Dave, but I’ll take a nice, safe 8% average return and no downside risk to the risk of losing 40% or more in a growth mutual fund in any given year.
The second reason that I think “buy term and invest the difference” is a myth is that under the hood, permanent insurance looks much like buying term and investing the difference. The difference, of course, is invested in the tax-advantage manner I just explained. Generally speaking, when you make a premium payment, the money is put into the policyholder’s account. The insurance company dips into this account to withdraw the cost of 1-year annually renewable term. The rest of the money is invested using the cap and floor strategy I just described. Dave thinks you won’t need life insurance when you are old. Permanent insurance will be there when you need it.
The third reason is the myth that the cost of insurance cost will eat up the cash when you get older. Mutual fund expenses average about 2% per year. Some name brand funds charge even more. These companies are helping themselves to that 2% of your money year in and year out whether the markets are up or down. Talk about being kicked when you are down!
My over-funded IULs typically average about 0.5% per year in total expenses in those years when you would think that the cost of insurance would be excessive. I love showing clients the policy fees and expenses pages of illustrations. I love to show somebody what the costs will be as a percentage of their cash value when they are 75, 85, and even 95 years old. Now please keep in mind that this is based on how I design a policy and it varies by individual and the length of time that the policy has been in force.
Finally, because the cash value is accessed via a loan from the insurance company, your PRINCIPAL stays invested even as you start taking retirement income! Imagine your retirement nest egg continuing to grow and compound year after year as if you never touched it.
“Buy term and invest the difference” can only be true if you can invest the savings better than the insurance company. I hope I have showed a few good reasons why I believe that permanent life insurance has some advantages over traditional ways of investing.
I promise to keep future articles a little shorter. I could easily write a book destroying this myth.